• Leading indicators of job growth are now almost all signaling better times.

As I've often noted, there are a variety of employment indicators; and they fall into leading, coincident and lagging indicators. I will work backwards in this report and start with the lagging indicators—specifically the unemployment rate and some of its components.

Unemployment rate lags Because the unemployment rate is such a popular metric, and we are quite emotionally attached to its significance, it's often connected to our confidence about the economy and the stock market. But as I've pointed out many times, the unemployment rate is a highly lagging indicator of both the economy and the stock market. Given that the stock market itself is a leading indicator of the economy, use the lagging unemployment rate as a stock market indicator at your own peril.

If you were to use the unemployment rate as a guide for when to buy stocks (and/or "buy" the economy), you should buy when the unemployment rate is at/near its high point and vice versa. Nearly always, by the time the unemployment rate has dropped to its lowest levels (when ostensibly we feel most confident), a bear market and recession are more likely.

Participation rate The labor force participation rate (LFPR) is a very important factor to consider when analyzing data around the unemployment rate. We remain of the view that its decline to the lowest rate since the 1970s is more structural than it is cyclical, and largely driven by demographics. Many aging baby boomers are starting to retire and it's estimated that this could be as many as 1.5 million workers annually. In addition, many workers are in the labor force, but working "off the books." There has also been a lift in the number of people going back to school to acquire the skills necessary for the jobs that are available. Finally, given the extension of long-term unemployment benefits, some workers have been less "incentivized" to look for work (now that insurance is running out for some, more are likely to step back into the pool).

Fed Chairwoman Janet Yellen has suggested the LFPR has plunged because workers have dropped out of the labor force due to discouragement and that as conditions improved, they'll come back. She believes the pool of "shadow workers" has been helping to depress wages.

But as Ned Davis Research pointed out in a report just published, her tale has three holes in their opinion:

1. There are both employed and unemployed people leaving the labor force. There are about 1.4 million more workers who leave the labor force each month from being employed than from unemployed. Moreover, there is a growing share of those out of the labor force who are staying out of the labor force … these workers are not coming back.

2. There are fewer people out of the labor force who say they want a job. As a result, the pool of available labor is shrinking at its fastest pace ever.

3. Wage statistics are flawed and compensation lags. Employment costs tend to lag economic recoveries by around four years. By the time we see wage inflation, overall inflation will be marching higher and the Fed will be behind the curve.

Short-term vs. long-term Another topic on which I've been opining lately is inflation and related labor force "slack." As you can see in the chart below, short-term unemployment is nearly back to its pre-recession level; while long-term unemployment is down, but remains high. It's generally believed that short-term unemployment is more important for wages and inflation. From High Frequency Economics: "The theory that short-term unemployment is more important than long-term unemployment in determining wage and inflation pressures…suggests that wages and inflation could edge up in coming quarters, particularly if short-term unemployment continues to decline."

Education factor Another interesting way to look at the unemployment rate is by education level. There remains a large spread between the unemployment rate of those with a college degree and those without a high school diploma; but for those in the latter category, the good news is that the decline in the rate has actually been the steepest among the categories since the recession ended.

Payrolls are coincident Let's move on to the more coincident employment measures, including payroll growth (the other "headline" number when we get the monthly jobs report).

Here I think it's important to parse out the private sector from the public sector, given the different phases each have been in as it relates to the economic and fiscal cycles. Given the recent "austerity" of the government sector (just now waning), private sector job growth has exceeded overall job growth by a meaningful amount. You can see a chart of the two below and should note that private sector employment is up 9% since its recession low and has surpassed its prior 2007 high. Overall employment, however, is up a lesser 5.9% and has not quite taken out its prior high. This is consistent with the fact that the average pace of real gross domestic product (GDP) growth since the recession ended is nearly a full percentage point higher for the private sector than the economy overall.

Claims, etc., lead There are other valuable leading jobs indicators worth monitoring; all of which have received increased attention lately. The first is the important data that comes from "JOLTS" (Job Openings Labor Turnover Survey). As you can see in the chart below, job openings have spiked recently.

And another embedded indicator within JOLTS has also picked up, which is the so-called "quits rate," measuring the percent of people voluntarily leaving a job. This is ostensibly a sign of an improving job market given that it signals their confidence in finding other employment. It's also a metric Fed Chairwoman Janet Yellen has often cited as a key indicator the Fed is monitoring.

Given that it's small businesses that are our economy's most robust job creators, we can take some heart from a pick-up in hiring plans within the survey done by the National Federation of Independent Business (NFIB). This is a hopeful, but not yet robust, indicator of coming job growth.

Part-timers Finally, I want to address another area that often gets debated—the uptick in part-time employment. Even though the latest jobs report was nearly universally strong, the share of the labor force working part-time (less than 35 hours per week) rose sharply in June, to its highest level in over two years. I recently read an interesting article on this subject by Ed Dolan in EconoMonitor. The summary take-away: "…most of those who work part-term do so voluntarily, for reasons such as child care, family or personal obligations, school retirement or Social Security limits on earnings. Involuntary part-term workers (part-timer "for economic reasons" in BLS terminology), in turn, fall into two categories. Some have jobs that are, in principle, full-timer, but which are not currently providing full-time hours because of slack business conditions.

Others have taken jobs that are part-timer because that is all they could find, even though they would prefer full-time work. The difference is that as business conditions improve, many in the first involuntary category will move back to full-time without a change of jobs, whereas many of the second will have to quit their part-time jobs to take different ones that offer more hours in order to return to full-time status."

"The bottom line is that part-time work is an important but ambiguous indicator. The 'part-time jobs are bad jobs' mindset is far too simplistic."

In sum The net is that things are improving. The likelihood that the unemployed will find employment has improved substantially in recent months; while the likelihood that the unemployed remain unemployed is receding at a more rapid pace. The unemployment rate is likely to continue to fall; but as it gets closer to what would be considered "full employment," inflation could become a bigger problem alongside higher wages. This could spell some trouble for the stock market; at least at the point the leading indicators are no longer supportive. That's not yet the case; but we should have it on our radar screens.

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